New instrument to help insurance cos avoid catastrophe

03-Mar-2010

The government has suggested the idea of a new financial instrument called catastrophe bonds that would help insurance companies to transfer the risk of disasters into the capital market, which is suited for investors who are hungry for high-returns.

Catastrophe bonds are popular among major institutional investors abroad as they typically pay investors a coupon of Libor plus a spread anywhere between 3% and 20% because they carry high risk. If any calamity occurs, then the principal initially paid by the investors will be used by the insurance firms to pay its claims to policy holders. But if nothing untoward happens, investors would end up making impressive returns on their investment.

Finance minister Pranab Mukherjee while presenting the Economic Survey 2009-10 on Thursday noted that catastrophe bonds are widely used in advanced countries and there is scope for introducing it in countries like India to provide insurance against contingencies.

"Capital market solutions for catastrophe risk insurance are another area that needs focus. This essentially transfers insurance risks of natural calamities like earthquakes, hurricanes and floods to the capital markets through the issue of catastrophe bonds," he said. While the proposal will help investors to diversify their investment portfolio and earn a higher return, the instrument will also help insurance companies to transfer their risk to the capital market.

"It is a welcome measure as it provides capacity to insurance companies to cover catastrophe. By this arrangement, risk is passed on to investors in a very innovative way," said SG Srinivasan, CMD, United India Insurance. The issuances of catastrophe bonds had almost doubled in the US following hurricane Katrina in 2006. The US witnesses issuances of such bonds worth nearly $4 billion annually.

Globally major institutional investors like hedge funds, pension funds, banks, asset managers and specialised catastrophe oriented funds among others have subscribed to these offerings as they generally pay them higher interest rate compared to similarly rated corporate instruments and also help them in diversification of their portfolio. Pointing to the dominance of institutional investors and corporates in the Indian capital markets with limited participation from retail investors the Survey noted that the inter-dependence between corporate houses and mutual funds has recently raised concerns relating to volatility in financial markets.

The recent financial market crisis has raised many issues about governance of financial intermediaries and awareness of investors. Hence the survey has stressed the need for greater investor awareness and protection programmes. "Neither will have the desired result in isolation," the Survey said adding that simultaneous and coordinated efforts on both fronts will help investors take well informed financial decisions. While mentioning the efforts undertaken to extend the reach of the New Pension System (NPS) to new segments like central and state autonomous bodies and the organised sector, the Survey pointed out the challenges faced by PFRDA in expanding the distribution network of the NPS to cover the entire unorganised sector in the country. The Survey said PFRDA should be given statutory backing along the lines of Sebi and Irda to perform its regulatory.

Source : www.insuremagic.com